Sustainable finance the way forward

Environmentally friendly business practices are gradually coming to the fore. With Net Zero Energy Buildings coming up in the Americas, Singapore, Dubai and across the globe whereby they are consuming only as much energy as that produced on-site, to countries taking up energy efficient and hybrid-electric cars, the move towards maintaining our eco-system is getting strong.

That is where sustainable finance comes in. Kenya, too, is geared towards the issuance of a sovereign green bond, a mechanism conceptualised as a plan to secure alternative funding sources to finance the Vision 2030 Social pillar of environmental management.

How has awareness of ecological conservation affected the investment scene? There was a time when investing was all about making as much money as possible. Fund managers would select sectors that gave them and their clients the greatest returns. Fossil fuels, weapons were all fair game. But the rules of the game are changing. Take climate change for instance. A recent report from the United Nations warns that the planet is on track to heat up by over 3°C by the year 2100. This poses a major risk to many investments.

Some assets suffered damage from extreme weather and rising sea levels while others could lose value as the world transitions to a lower carbon economy. Investors, fund managers and financial specialists are increasingly conscious of these risks and are looking at ways to begin accounting for them. Sustainable finance means making investment decisions that consider social and environmental impacts rather than purely the financial returns. It is also referred to as green finance or ESG finance.

Economic growth

According to the European Union, sustainable finance not only promotes economic growth but also considers what is known as ESG, which stands for Environmental, Social and Governance factors.

Environmental factors include greenhouse gas emissions, biodiversity loss, water consumption and pollution. Social factors include human rights and equality, labour relations and health and safety.

Corporate governance factors include executive pay, transparency, board independence and shareholder rights. These ESG factors differentiate sustainable finance from regular finance. It can be true to say that sustainable finance is considered a recent phenomenon.

There is a consensus among relevant stakeholders that green finance should become a priority in Africa. It is already making a mark across other regions of the developing world. Green funding for “green” infrastructure projects can stimulate inclusive growth and address socio-economic inequality too.

The world’s first green bond was only issued in 2007. However, this sector has grown swiftly ever since. In 2020 a record $554 billion worth of sustainable bonds were issued across the globe, this is over double the amount issued in 2019.

ASEAN (Association of Southeast Asian Nations) green bond issuance almost doubled year on year between 2018 and 2019 to $8.1 billion, with major banks also giving greater financing for projects involved in renewable energy, energy efficiency, clean transportation and so forth.

As the Covid-19 continues shaking the global economy, many financial experts believe sustainable investing is becoming the new normal. Why do we need sustainable finance? One of the debates is that the planet is hotter than it has been for the last 12,000 years.

According to Reinsurance Company Munich Re and the National Centres for Environmental Information, it is estimated that Last year‘s (2020) worst climate disasters caused at least US $210 billion worth of damage around the world attributed to climate change.

Environmental crisis

Climate change is not the only environmental crisis we are facing. We need to protect biodiversity and avoid the endangerment of species and maintain our ecosystems. Healthy ecosystems provide the basic necessities for human survival including food, clean water, energy and carbon sequestration. These ecosystem services contribute most of the world’s GDP giving food security to the masses, yet many countries are at risk of losing out through progressive damage leading to possible ecological collapse.

The good news is that we can easily combat both climate change and biodiversity loss by restoring our planet's ecosystems. The bad news is we are not spending nearly enough on tackling these issues. Humanity will need to spend an extra $600-$800 billion per year to reverse biodiversity loss by 2030. Is there a business opportunity in this?

It would cost $2.5 to three trillion to achieve all of the sustainable development goals. So how exactly can sustainable finance help with these massive gaps in funding? There are six main groups of sustainable financers; banks, corporations, institutional investors, central banks, international financing institutions, and green funds.

How do investors determine which potential investments are in line with their values? One of the main ways is by integrating ESG criteria into investment decisions.

For instance, a less polluting company may be given preference over one causing mass pollution. Another way is to exclude certain investments from a portfolio through a process known as ESG screening.

There are three types of screening: negative screening, positive screening, and norms based screening. Negative screening means not investing in sectors or companies that perform poorly on ESG usually including practices that are socially or environmentally harmful including fossil fuels and gambling. In contrast, positive screening means only investing in sectors and companies that perform well on ESG.

Between these two extremes, there is also norm based screening. Here, rather than only investing in the best ESG performers or excluding the worst performers, norms based screening involves looking at investments against international standards.

These include alignment with corporate recommendations such as the United Nations Global Compact. Africa is perfectly positioned to become a foremost player in the global sustainable finance market.

With ever increasing funding needs, sustainable finance can shape the continent's role in bringing together local and foreign capital for impactful projects.

Ritesh Barot is a business and financial analyst, humanitarian, conservationist, occasional artist, recipient of OGW honor. [email protected]